Recommendations to Transfer IRAs

This is my 51^st article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

The new fiduciary regulation includes, among its definitions of fiduciary advice, a recommendation to an IRA owner to transfer the IRA from another firm. As a result, the recommendation, if accepted by the IRA owner, will automatically result in a prohibited transaction. That is because, if the recommendation is accepted and the IRA is transferred, the adviser will obviously make more money than if it were not. That is a financial conflict of interest that is a prohibited transaction under the Internal Revenue Code.

Fortunately, there is an exemption, or exception, called the Best Interest Contract Exemption (BICE). However, BICE comes with conditions . . . the adviser and his or her supervisory entity (typically a broker-dealer or RIA firm) must comply with the Impartial Conduct Standards. There are three Impartial Conduct Standards:

• The adviser (and the supervisory entity) must adhere to the best interest standard of care (which includes the duties of prudence and loyalty).
• Neither the adviser nor the supervisory entity can receive more than reasonable compensation.
• The adviser and the supervisory entity must not make any materially misleading statements.

This article looks at the requirement to engage in a best interest process.

The first step of a best interest, or prudent process, is to determine the information that is “relevant” to making a decision that is “informed.” In other words, what would a person who is knowledgeable about such matters, and who is unbiased and loyal to the IRA owner, want to review in order to develop a recommendation? Unfortunately, there aren’t any specific guidelines in the fiduciary regulation or BICE. However, it seems reasonable to conclude that, at the least, the following would be required in most cases:

• The investments, services and expenses in the current IRA.
• The investments, services and expenses available in the IRA that the adviser will recommend.
• The needs, objectives, risk tolerance and financial circumstances of the IRA owner.

In the typical case, that may be enough. However, in some cases, there may be special circumstances that would require considerations of additional factors.

Once those considerations have been identified, the next step is to gather the information; that documentation should be retained in retrievable fashion in the event of SEC or FINRA examinations, IRS audits, or private claims.

The next step is to analyze the information. For example, if the investments and the expenses are similar for both the current IRA and a new IRA, the key is to consider the services in light of the needs and circumstances of the IRA owner. With that in mind, in this new fiduciary world, advisers and their supervisory entities should focus on the services that they will provide to retirement money, such as Individual Retirement Accounts. Generally speaking, the investment of retirement money (at least, based on guidance from the Department of Labor) involves considerations of generally accepted investment theories—such as modern portfolio theory, and of prevailing investment industry standards. Ordinarily, that would include strategies such as asset allocation, diversification among and within asset classes, portfolio construction, and so on. Those are “services” that are consistent with the best interest standard of care and that could justify a prudent, or best interest, recommendation to transfer an IRA.

The considerations listed in this article are not exclusive. There are many other factors that could reasonably be considered in developing a recommendation to transfer an IRA. The key, though, is that the appropriate documentation be gathered, a thoughtful analysis be made, and the recommendation be prudent and loyal.

The best interest fiduciary process is a new way of looking at everyday transactions and making recommendations about those transactions. It’s important for advisers to realize that it’s not just a compliance issue; instead, it’s a process . . . a thoughtful, documented, best interest process.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.